When dumb money beats smart money, it’s time to worry

There’s a strange twist in today’s stock-market narrative: while some of the so-called “smart money” struggles, the “dumb money” - i.e. retail investors with a long track record of under-performance - is unexpectedly winning. 

In his piece below, Owen A. Lamont, Ph.D., of Acadian Asset Management, argues that when the crowd of amateur punters begins outperforming the institutions, the warning lights start flashing. 

This is not a mere quirk of luck. It may signal froth, feedback loops and a market tilting into bubble territory. As we digest the signs, the key question emerges: are retail victory laps a bullish anthem or the opening act of the next correction?

Dumb money triumphant

The article below was written by Owen A. Lamont, Ph.D., Senior Vice President, Portfolio Manager, Research at Acadian Asset Management

Is the U.S. stock market in a bubble? I doubt we’re there yet, but one sign of speculative froth is the recent success of retail investors. On average, retail investors exhibit anti-skill in their stock selection decisions, meaning that their holdings underperform the market. So when retail investors are winning, that tells you that market conditions are unusual.

It is fair to describe retail investors as “dumb money.” While some find this phrase offensive, I think it’s accurate. The word “dumb” is meant to describe their behavior, as opposed to their innate intelligence. Retail investors include highly intelligent and educated professionals, such as doctors and dentists. But they have a well-documented habit of making investment decisions that result in significant destruction of their own wealth, in other words, dumb behavior. Similarly, if finance professors ever try to perform surgery on themselves, it would be fair to call them “dumb surgery.”

When market prices get dumb, the dumb money gets rich. The initial success of the first wave of dumb money motivates a second wave of dumb money, which pushes up prices further. This feedback loop, Shiller’s “naturally occurring Ponzi scheme,” creates market bubbles. Lefèvre (1923) writes:

The big money in booms is always made first by the public – on paper. And it remains on paper.

According to this view, retail investors win in the initial stage of the bubble, but eventually lose when the bubble deflates.

Here’s one story about the tech-stock bubble. Retail buying drove up the price of tech stocks such as Cisco, attracting yet more retail inflows. By the end of 1999, Cisco was one of the best-performing stocks, and retail investors, as a group, had outperformed. Call this retail outperformance “dumb alpha.” As of 1999, not only were tech stocks overpriced compared to other stocks, but the whole market was overpriced as its composition tilted toward tech. Thus, by late 1999, trailing positive dumb alpha coincided with an overpriced market.

This retail success couldn’t last, because prices eventually return to fundamental value. Thus, the positive dumb alpha of the late 1990s turned into the sharply negative dumb alpha of the early 2000s as the bubble deflated. Over long periods, retail investors lose, so dumb alpha is negative on average. However, during speculative episodes such as 1999 and 2021, dumb alpha can be positive.

As of today, unthinking fools are once again flourishing while those who follow reason’s rules are not. We see ample evidence of positive dumb alpha in the U.S. stock market, as retail investors have outperformed the broad market over the past year.

Figure 1 shows cumulative returns on two ETFs reflecting retail investor holdings of U.S. stocks, one for U.S. investors and one for Korean investors. For U.S. retail investors, the SoFi Social 50 ETF consists of the top 50 holdings of clients of SoFi, a brokerage primarily serving U.S. customers. For Korean retail investors, the Samsung KODEX Investor’s Choice ETF consists of the top 25 U.S. common stocks held by Korean retail investors, as reported by the Korea Securities Depositary. In the past year, both of these ETFs have greatly outperformed, with total returns more than double those of the broad U.S. market, as measured by the Vanguard Total Stock Market ETF.

Figure 1: Smart money vs. dumb money

Since the dumb money is winning, you know that the smart money must be losing. Short sellers have been among the smartest money, historically. Typically, the stocks that short sellers sell are the same stocks that retail investors buy, as shown by McLean, Pontiff, and Reilly (2025). On average, short sellers win, since the stocks they short subsequently underperform. But lately, short sellers have been losing. Figure 1 shows the performance of the Goldman Sachs basket of most-shorted stocks. When these stocks go up, the smart money is hurting. The smart money has endured quite a bit of pain, especially in the past few months.

Dumb money winning, smart money losing—that’s a market heading down the road to crazy high prices for some popular stocks and possibly crazy high prices for the whole market. We saw a similar configuration of performance in 2021, which was followed by a decline in the whole market in 2022, but an especially severe decline in retail favorites, as the dumb alpha turned sharply negative.

Historically, stock market bubbles (and, more recently, crypto bubbles) have been fueled by stories about ordinary people becoming fabulously wealthy through their investments.

Of course, it’s always possible to find winners in the stock market, just as it’s possible to find winners at the casino, so these anecdotes are only suggestive. That’s why the aggregate evidence shown in Figure 1 is helpful.

So, is it time to get out of the stock market? I don’t know, but maybe you should ask some retail investors!